Owning REITs through ETFs

Because investors usually buy REITs for their yields, these investments tend to be vulnerable to rising rates. However, economic growth can offset some of this risk, explains Mark Salzinger, editor of The No-Load Fund Investor.

As the economy grows, demand for new development as well as the rents REITs can command tend to rise — and can do so even as interest rates increase.

With the US economy growing steadily, if sluggishly, and the Federal Reserve tentative about further rate increases, REITs appear to be in an attractive spot in their business cycle. Furthermore, their financial health is solid overall.

Over the past five years, both have returned 12.2% on an annualized basis. VNQ recently yielded 3.8% to SCHH’s 3.2%.

Both have a considerable yield advantage over the recent yield of the S&P 500 (2.1%) and the 10-year U.S. Treasury note (1.5%).

VNQ is the broadest ETF to focus exclusively on property-related REITs. It tracks the MSCI U. REIT Index of about 150 REITs, more than any other ETF peer.

Its breadth gives it more exposure to smaller REITs; nearly 20% of its portfolio is allocated to small caps. Its exposure to the various REIT sub-sectors represents their overall market value, and is largely similar to that of other REIT ETFs.

Retail is the largest category (24% of the portfolio), followed by specialized REITs (18%), residential (16%), office (12%) and healthcare (12%).

Each of these sub-sectors has its own unique characteristics, but most are buoyed by the same economic factors of steady growth, low unemployment and low interest rates.

VNQ levies a 0.12% expense ratio. It is by far the largest REIT ETF by assets (with an additional $27 billion in its mutual-fund share class), and the most easily traded.

SCHH has a (slightly) lower expense ratio (0.07%) than VNQ. but in a narrower segment of 100 REITs that includes only about 15% small caps.

Most investors should go with VNQ. Schwab brokerage customers should choose SCHH, which is available to them without a commission.